The Case of the Dwindling Cash Flows

By Randy Myers

Many stable value funds are shrinking, but the principal reason, it turns out, is not because retirement plan participants are withdrawing money from them. Rather, exchanges of money into stable value funds from other asset classes have slowed. That downturn may be attributable to participants looking for higher returns elsewhere at a time when stock prices, bond yields and money market rates have all been climbing.

Those are the conclusions of five leading executives from the stable value industry after analyzing cash flow data at their organizations to understand what’s behind the recent decline in stable value assets. Their firms collectively represent more than 90,000 defined contribution retirement savings plans, more than 25 million plan participants, and nearly $2 trillion in record-kept assets, including more than $200 billion in stable value assets.

“Over the decades we’ve seen cash flows go up and down multiple times,” said Aruna Hobbs, head of institutional investments at MassMutual, in leading her colleagues in a discussion of their findings at the 2023 SVIA Fall Forum. “What’s intriguing is that this outflow comes at a time when stable value market values are significantly below book values, interest rates have risen, and we’re not seeing stock markets slowing down. We’ve seen (net negative) cash flows in the industry anywhere from 7% to 12%, and as high as 30% at some outliers. The question is, is this pattern causation or coincidence?”

Heading into their investigation, Hobbs noted, theories about why assets were shrinking were numerous. Some in the industry suspected that financial advisors were recommending that inactive plan participants and retirees leave the plan and move their money into money market funds, which for the moment are yielding more than stable value funds thanks to the sharp spike in interest rates over the past year and a half. Others theorized that households struggling to keep pace with inflation might be making hardship withdrawals from their retirement plans and taking that money from their stable value funds. With the S&P 500 stock index climbing steadily from early October 2022 through the end of July 2023, still others guessed that plan participants might be moving money out of stable value funds and into stock funds, which would be more common.

At a high level, Hobbs and her colleagues reported, the defined contribution retirement plan market itself remains healthy. Jeff Clark, senior product owner at Vanguard Group, where he leads defined contribution thought leadership, noted that average plan participation rates at plans on the Vanguard platform are at an all-time high of 85% as revealed in the firm’s 2023 “How America Saves” report. With a majority of plans now offering automatic enrollment and many increasing deferral rates annually, the average deferral rate is now at an all-time high of 7.4% of participants’ salaries, too. Hardship withdrawals have risen since the COVID-19 pandemic hit in 2020 but were still used by only 2.1% of participants in 2021 and 2.8% in 2022. The percentage of plans offering stable value funds has been edging higher since 2018—to 68% in 2022—although the percentage of participants using those funds where offered has been trending lower, to 10% in 2022 from 14% in 2018.

Tony Luna, head of stable value asset management at T. Rowe Price, reported that outright withdrawals from stable value funds were a big driver of negative cash flows at the start of this year at plans on his firm’s recordkeeping platform. The number of plan participants making withdrawals didn’t change significantly, however, which he viewed as a positive. Nor did the types of withdrawals change much—about 80% went into Individual Retirement Accounts (IRAs), and about 20% were lump-sum withdrawals. Luna theorized that some of the increase in the size of withdrawals may have been attributable to participants trying to cope with higher living expenses amid high inflation. Much of the money going into IRAs, he added, was being directed into money market funds.

In any event, Luna said the more surprising finding was that while exchanges of assets out of stable value funds and into other investment options have held relatively stable, exchanges into stable value have fallen, such that net exchanges turned negative. That is something that has happened only a handful of times since the middle of 2017.

It’s too soon to draw any trends or secular patterns from the cash flow activity during the first eight months of the year, Luna cautioned. Still, he said that while the negative cash flows have thus far felt different than similar events in the past, he does not consider them alarming. He further noted that the net outflows may reflect to some degree a natural reversal of developments in 2022, when stock and bonds markets were both in a funk and stable value funds took in substantial sums of money.

Neena Saxena, head of stable value investments at Vanguard, said cash flow data at her organization over the past 18 months paint a picture similar to the one described by Luna. After she and her Vanguard colleagues reviewed their work, she added, they concluded that “the situation is not as dire as we initially thought.”

She pointed to a handful of key findings. First, she noted that stable value funds have been a “net negative” or “net withdrawal asset class” every year since 2020, with much of the outflow moving into target-date funds. Accordingly, negative cash flows this year should not necessarily be viewed as exceptional.

Second, as was the case at T. Rowe Price, the biggest change in cash flows so far in 2023 versus 2022 has been a steep decline in exchanges into stable value funds. In 2022, high levels of “exchanges in” helped mask the volume of outright withdrawals.

Finally, she said, Vanguard hasn’t seen evidence of large-scale interest-rate arbitrage within individual retirement plans, in which stable value investors would be moving money from stable value into a money market fund. She credited that to competing fund rules working as designed. (Competing fund rules prevent participants from moving stable value assets directly into a money market fund within their plan, requiring that they first transfer that money into a non-competing fund, such as a stock fund, for a fixed period, usually 90 days.)

Tom Manente, assistant vice president, stable value solutions, at Empower Investments, said his firm examined a sampling of retirement plans on its recordkeeping platform for the months of December 2022 through February 2023. Among other things, it wanted to find out if negative stable value cash flows were due to plan participants taking withdrawals to fund their retirement, if they were a result of participants separating from service with their employer (leaving for a reason other than retirement), or if they were attributable to plans terminating their relationship with their stable value fund.

The biggest change Empower found, Manente said, was a substantial increase in withdrawals related to separation of service during the three-month period it examined. In fact, those types of withdrawals then became the largest driver of disbursements in March 2023. Empower also saw in March that, compared to February, participants were moving higher percentages of their money out of their plans just before their plans moved to another recordkeeping platform. He theorized that this may have been a result, at least in part, of advisors recommending that participants move their money into an IRA.

The executives were generally optimistic about the outlook for their industry. Saxena said the fundamental value proposition of stable value is enduring and predicted that cash flow trends will moderate once the current financial market environment shifts.

Manente noted that his firm has had a good sales year and has been able to retain higher-than-expected percentages of the stable value business it purchased from competitors in recent years. He added that retirement plan consultants, especially those working with larger plans, have been doing a good job of educating plan sponsors about the long-term value of stable value as an asset class even though money market funds are, for the moment, boasting higher yields.

Luna reminded his colleagues that higher interest rates ultimately will be good for the stable value industry, as they eventually lead to higher stable value crediting rates and potentially more growth opportunities. And he said that when interest rates do turn down, stable value yields will start to look more attractive relative to money market yields, which likely will drop faster.

Still, Luna said the negative cash flows the industry has been experiencing shouldn’t be ignored.

“We need to grow the pie,” he said. “We should not be dependent on ‘exchanges in’ to not have panels about cash flow at our conferences.”